The global pandemic was the spark that accelerated two trends in financial market participation: technology-enabled lower cost trading and the rising cost of attention.
On one hand, higher financial market participation has been a long-time objective of various policymakers around the world. Having a larger proportion participate in the economic and financial market growth and development of a country is a democratised way for the entire population to grow their wealth.
But on the other hand, uninformed amateur stock trading may also result in exposing one’s life savings to risks that may not be associated with a reward, distraction from other activities, and addiction.
1) Other investment opportunities
For every investment we make, we forgo a whole range of other possibilities. Therefore, in chasing after one popular stock, we may miss out on the opportunity to invest in another fledging company which may actually be a long-term winner.
In addition, we may decide to hold securities, which have lost money, for a longer period in hopes of recouping losses. We may decide to take more risk following gains from an investment, thinking that at least we would have broken even, or thinking that the good returns will continue.
But these behaviours miss a key fundamental lesson which finance professors teach: money has an opportunity cost. Expecting to break even for a risky investment is a pretty low bar. Instead, remember there is an opportunity cost for that money. It is fungible and could have been used for a variety of other things, from treating yourself to a nice dinner to investing in another security which may have provided a better return.
The concept of opportunity cost is arguably the most important concept from all of economics, and in fact motivates in the next hidden cost as well: your attention.
2) Attention and mindshare
With the wealth of online entertainment instantly accessible in a single smartphone, all kinds of apps compete with each other for our attention. In fact, the Social Dilemma documentary on Netflix makes a case that in trying to optimise for engagement, Facebook may have stumbled into promoting political posts as they generated the most reactions.
Trading platforms compete for your attention as well. Since attention is so sparse, these brokers – which either directly or indirectly make money through your trading activity (aka your engagement) – must also come up with means to keep you using the platform. Gone are the clunky trading platforms of old where a single login into the trading account requires the consultation of a physical card for a security key, before a heavy application filled with hundreds of obscure moving numbers pops up on a screen. Now, a clean application loads up with intuitive buttons, concise descriptions of various actions and securities, and large buttons for buying and selling.
However, simplification and gamification may not be beneficial for investors. An academic study finds that simultaneously showing cross-market data helps investors attain better trading prices. So, more may be better than less here.
Trading nowadays is easy and fast. We can react to any news developments much faster than before. And in a more connected world, news can travel faster as well. But having such a wealth of information is a two-edged sword from a human perspective. Just as it becomes easier for us to access news from all around the world and act on the information, it also raises the opportunity cost for all the other activities we do, be it family time, meeting friends, or date night with a significant other.
3) Addiction
Low-cost trading applications such as Robinhood have fuelled the rise of novice traders who behave more like gamblers rather than investors. Robinhood’s interface simplified trading substantially. Features like falling confetti and emoji-filled phone notifications make it feel like a game. A quick glimpse at the interface looks reminiscent of the machines sitting in a casino.
In fact, even if we are aware of the opportunity costs we are incurring, we struggle to resolve it. That is exactly the definition of an addiction. The Institute of Mental Health here in Singapore defines addiction as a “chronic, progressive, and relapse-prone illness that affects a person both physically and psychologically”, and is characterised by (1) continuing the addictive behaviour despite the consequences, (2) the frequency or intensity of the behaviour increases over time, and (3) when stopped, the person experiences unpleasant emotions.
Stock trading has similar features: it comes with promises of opulence as huge winners are covered by the news media; it is high-paced; and thanks to discount brokers, it is also easily done and doesn’t actually require a trip to the casino. Arguably, because the probabilities of winning or losing in the financial markets are not known (unlike in a casino), it can be even more exhilarating.
Two tips for traders
Probably the hardest truth for traders is that even if we are aware of the opportunity cost in terms of other investments and our attention, as well as the potential for addiction, we may have a hard time resolving them. Awareness is the first step, but the next step requires work. Thankfully, there are two things we can do to help guard us from this risk, and more importantly, help us to learn.
Trading log
First, keep a trading log which documents your opinions and bets. Then, you should periodically review your trading log, for example when you close a trade. This review provides a point-in-time perspective of your thoughts. This allows you to learn from past mistakes, if any. An academic study finds cognitive reflection helps traders avoid behavioural biases.
Unfortunately, without writing it down, we tend to overwrite the past with our perspective of the past, a widely-known psychological phenomenon known as “memory bias”. In fact, academic research finds evidence that inexperienced investors are unable to provide a reasonable assessment of their own realized trading returns.
Unfortunately, the most robustly documented effect is a positive memory bias, meaning that we tend to remember the winners and forget the losers.
Write down pre-specified rules
Second, you can try to set well-defined rules for yourself in terms of a trade horizon, the maximum trade size, and the frequency at which you will check the trade. But unfortunately, we humans are notoriously bad at following our own rules, and whenever our behaviours don’t coincide with our beliefs, we simply tend to change our beliefs rather than our actions (this is known as “cognitive dissonance”).
This inability to commit to following rules is where machines have a clear advantage. Quantitative algorithmic trading can reduce the attention cost on the investors. Unfortunately, implementing such a rules-based system also requires some level of technical sophistication. Alternatively, you can delegate someone else to trade on your behalf, such as trading into a fund. Segregating core long-term investment assets from a gambling/speculation/play trading account can also help to improve the discipline.
Conclusion
Only by being aware of both the full suites of benefits and costs of day trading can we make informed decisions. In a fast-paced world where so many things compete for our attention, we need to slow down at times, so that we can make more conscious and deliberate decisions in investing wisely for the long term.
For some whose opportunity costs of time are high, the wisest decision may be not to day trade at all. In that case, they can still participate in financial markets through other means such as financial advisers or investing in funds which require less day-to-day attention.